60 second recommendation
The 529 Savings plan is usually the way to go for married couples making over $130,000/year in 2026. If you make less than that, saving taxes on dividends and capital gains, which is what you get with a 529 plan, isn’t worth much to you because you’ll likely be in the 0% capital gains & qualified dividends tax bracket. Of course, you also want to be quite certain that you’ll use that 529 money in a tax-free way (i.e.: private school tuition up to $10K/year, or college costs.)
For affluent families (probably everyone reading this…), the 529 plan allows you to sock away money in an investment account which grows tax-deferred. If the beneficiary you designate– your child, or yourself if you’re going back to school– spends the money on private/public/parochial preschool (potentially) and K-12 tuition and required fees (only, and up to $10 K per year max!), or on higher-education costs like college tuition, books and supplies, laptops and internet (if required by the school), and room and board, they can withdraw the money tax-free as well. This tax treatment is akin to the Roth IRA, but for education rather than retirement. Here’s a full list of IRS-approved educational expenses. Skip down to the Qualified Tuition Program (QTP) section.
What if I don’t use it for education?
If you use the money for something other than approved education expenses, you’ll have to pay regular income taxes on the earnings (which are generally higher than capital gains taxes you’d pay on a taxable account) AND a 10% penalty on the earnings.
Avoiding the penalty on withdrawals
Certain scenarios allow you to avoid the penalty, but NOT the income taxation, including if your child receives a scholarship. You can then remove an amount equal to the scholarship and only pay income tax. (Which still sucks, since long-term capital gains rates have historically been much lower than regular income tax rates.)
Roth IRA rollovers from 529
In 2022, Congress allowed rollovers of 529 plans to make regular contributions to a Roth IRA held by the beneficiary of the 529 plan (i.e.: your child.) You’re limited to the annual max contribution– but the income limit apparently does not apply– meaning your child must have earned income to contribute, but doesn’t have to worry about making too much to do the rollover — and a lifetime max of $35,000 in total rollovers. The 529 plan in question also must have been opened for at least 15 years. No contributions or earnings on contributions from the last five years can be transferred either. Check to make sure there are no other requirements as well for your situation.
Transferring between sibling 529s
If you need to use money from one 529 to pay for another child’s tuition, simply transfer the funds from Sibling A’s 529 to Sibling B’s. The IRS treats these transfers as beneficiary changes, not rollovers, it seems, so you can do an unlimited amount of these transfers per year. (Vs the 1 year SAME beneficiary transfer of a 529 plan to another plan.)
Student loan payments from 529
Per this, “[F]amilies with 529 college savings plans are limited to withdrawing up to $10,000 [Federal] tax-free [and penalty-free; check on your state’s taxes, however] for use toward qualified education loans. Also note that the $10,000 limit is per lifetime, but it can apply to more than one dependent. If a family has three kids with student loan debt, for example, they could withdraw $10,000 in tax-free funds for each child from their 529 plans for a total of $30,000.”
Note that you cannot deduct student loan interest on anything you pay off with that $10 K from your 529. I.e.: No double-dipping!
How cost basis is treated for non-qualified (taxable) withdrawals
529 basis for taxable distributions is apportioned via the cream in the coffee (proportional) rule.
Note that while your ‘basis’ (the money you put in) comes out tax-free, you can’t just take out the basis and leave the earnings. Instead, any distributions you receive will have the proportion of your basis included in it. For example, say you contributed $10 K and the account is worth $30 K. If you take out $3,000, $1 K will be your portion of the basis, and you’ll pay regular income taxes on the remaining $2 K.
If your child gets a scholarship, you can take out an amount up to the scholarship value without paying the 10% penalty, but you’ll still owe income taxes as compensation to the IRS for the tax-free growth you enjoyed.
What fund to open and where?
First, check to see if your state’s 529 plan has any special benefits that might make you choose it (note to Washington residents: our 529 plan doesn’t have anything special as of this writing, so you can safely ignore it). (There’s also these even more detailed plan feature comparison that you can check.)
If your state does NOT have any such benefits (like state income tax breaks on contributions, say, or matching dollars from the gov’ment), then head on over to either Fidelity for their national (New Hampshire) plan and choose from their index fund options, or to Vanguard, and open their (Nevada) 529 plan.
For investments, I recommend the ‘set it and forget it’ age-based Target Enrollment options. I think this fund switches to quickly into bonds and cash, so consider picking the option 4 years after your child turns 18/will start college. So, if your child was born in 2020 and will attend college in 2038, choose the 2042 plan instead (i.e. the year they turn 22.)
If you go with my recommendation, your child will have about 30% of their money in stocks when they turn 18, and it will drop further as they go. For me, that’s an acceptable amount of risk, especially given that I’ll hopefully have more money at the start since I stayed in stocks longer vs the default option.
Note that you can only donate cash to a 529 plan. You’re not allowed to gift, say, appreciated stock to it as a way around capital gains from an earlier taxable account.
Californian 529
California tried and failed to pass a state income tax benefit for their 529 plan. As of 2024, no benefits exist, but you COULD open the Cali 529 here in case they pass benefits later, to avoid having to move from, say, Fidelity. The Cali plan has low fees and good options. Choose from index fund options or target date index fund options there (don’t do the ‘guaranteed’ option unless you really know what you’re signing up for.)
CAUTION: Note that those scrooges in California will hit you with both state income taxes AND a 2.5% penalty surtax on any 529 plan withdrawals that you use for up to $10 K per year for K-12 tuition. These withdrawals are free from Federal income taxation, but not those money-grubbers in Sacramento…
Washington state 529
Choose a national plan since Washington has no state tax or associated benefits with their 529 plan as of writing.
Oregon 529
Oregon has a modest incentive for contributing to their plan: https://www.oregoncollegesavings.com/tax-benefits
Keep reading for the details on the 529 plan
As of writing in 2021, a 4-year public university in-state tuition is expected to be around $200,000 in 18 years. Run your own estimate here. You can check what a single year of University of Washington costs right now. Out of state or private tuition might be $300,000. How are you going to pay for your kid’s education? (Or your own, if you’re planning on going back to school.) College tuition has been rising at an obscene rate, much faster than inflation. To meet your education savings goals, you need to invest, and you need to start right away to give your money a chance to grow. How early you invest is the biggest factor in your future wealth. Read the below and start socking away money for education today.
Whether you want to send Junior to an Ivy League private institution or a public state school (where serious students are powerless against the drunken jock-ocracy), I can tell you where to put your college nest egg to get the most bang for your buck.
There is really only one worthwhile education savings vehicles to choose from:
The state 529 savings plan. This can be any state’s plan, not just your own.
(I used to include the Coverdell ESA as a worthy second option, but its benefits are so mediocre now since the 529 can be used for K-12 tuition, that it’s not even worth mentioning.)
How the 529 Savings plan works
The 529 Savings plan allows the money you contribute for a designated beneficiary (like your child) to grow tax-deferred. The distributions (money you later take out of the account) are tax-free as long as they are then spent on qualified education expenses (defined later.) (Unlike, say, a 401k, there’s no option to deduct your contributions to these education plans from your taxable income.)
– 529 savings plan distributions are only tax-fee for post-secondary expenses (like college.)
– Unlike the Coverdell ESA, you can contribute for a beneficiary of any age (even yourself or your spouse!) If plans change, you can transfer the account to an eligible beneficiary. These include the beneficiary’s kids, grandkids, siblings, parents, neices/nephews, aunts/uncles, in-laws, first cousins, and all those folks’ spouses (including the beneficiary’s.) (Step-family count too.) This means you could start a 529 for yourself to go back to school, and if you don’t use all the money, give it to your spouse, kids or even grandkids. You can change beneficiaries multiple times for multiple generations to create a ‘dynasty 529’ as well, if you’re careful.
CAUTION: Note that if you transfer the 529 to a beneficiary of the same generation (i.e.: from one child to another) or ‘upwards’ to an older generation (i.e.: yourself, or your child’s aunt), you won’t incur gift taxes. BUT, if you transfer it to a later generation (earlier is apparently fine too; like to yourself/a parent of the beneficiary), the transfer WILL be treated as a gift and could incur gift taxes.
“Eligible members of the family include the beneficiary’s:
- Natural or legally adopted children
- Parents or ancestors of parents
- Siblings or stepsiblings
- Stepchildren
- Stepparents
- Nieces or nephews
- Aunts or uncles
- The spouse of any of the individuals listed above
- The spouse of the beneficiary
- First cousins”
“Generally, there are no gift tax consequences when account balances are rolled over to a different plan for the same beneficiary, or when you make a beneficiary change, provided the old and new beneficiaries are qualified family members and are in the same generation (e.g., siblings).”
– These plans are offered by states, and you can invest in ANY state’s particular plan (not just your home state.) It pays to shop around, and you should always at least glance at your home state’s plan to see if there are any special benefits in it for residents (like state income tax breaks.) I checked in my home state of Washington, and there’s no special benefits for residents. So if you live in Washington state, see the Utah plan below.
– There are no income limitations for contributors, so you can make millions and still contribute to a 529 plan. Also, you can contribute as much as you like in a given year, but only up to the gift tax exclusion limit ($18,000 per donor per beneficiary in 2024) to avoid eating into your lifetime estate tax exclusion or paying a federal gift tax. States have limits on total 529 account balances, but they tend to be so high it’s not relevant to most parents. (Like, $500 K, say.)
You can ‘superfund’ your 529 plan with 5 years’ of contributions made in one year
Like this. Rules: gifts MUST be applied over 5 years. Any differences between your annual 1/5 gift amount and the gift tax limit can be gifted separately. I.e.: you made an $80 K gift ($17 K limit * 5 years) in 2023, and since the limit is $18 K in 2024, you can gift an extra $1 K in 2024.
How 529 Savings plans affect federal financial aid
For federal financial aid planning, both Coverdell ESAs and 529 Savings plans count as parental assets. This is a good thing because in Financial Aid’s eyes, parent’s are only expected to contribute ~6% of their non-retirement, non-home assets, while kid’s are expected to contribute 35% of theirs.
(Note that this exclusion of retirement assets in financial aid calculations is a good reason to have your kid start a Roth IRA once they have some high school job earnings. The IRA will exclude their assets from financial aid calculations, whereas a savings account or taxable stock account wouldn’t.)
Can I use the 529 for non-US schooling or study abroad?
The short answer is ‘yes’ both full time and study abroad for US credit count for 529 plans, so long as school is eligible. Here’s the list of eligible international schools.
Can non-US citizens use 529 plans tax-free?
No, unless they are a ” a U.S. citizen or resident alien with a Social Security Number or Individual Taxpayer Identification Number” at the time they are made a beneficiary of the 529 plan. Additionally, at least one 529 account owner (i.e.: parent, grandparent) must be a US citizen. Six plans as of writing allow resident alien ownership.
If the beneficiary is an expat (non-US citizen or resident) who you expect to be a US resident when they need the money– let’s say your child lives abroad with a foreign parent and you’re in the US and you expect them to go to school in the US later and obtain residency– you could open an account for yourself and then switch to the beneficiary once they obtain a social security number/TIN, but keep in mind any generation-skipping gift tax exclusion issues.
Pre-Paid Tuition plans
Compared to 529 Savings plans, which I discuss below, Guaranteed Tuition plans like Washington State’s GET plan are counted as the student’s assets, and thus diminish financial aid eligibility. This is one reason I don’t recommend them. Another reason is that the plans guarantee to cover only in-state public school tuition amounts, even if you can use the money at other states’ schools. Also, many plans only cover tuition and required fees, which is often just a fraction (albeit a large one) of the total cost of attending college.
Summary of Washington State’s GET plan
You can read more here:
GET account values are measured in “units,” where 100 units equals the cost of one year of resident, undergraduate tuition and state-mandated fees at Washington’s highest priced public university.
[…]
The value of each GET unit is tied to the cost of resident, undergraduate tuition and state-mandated fees at Washington’s most expensive public university, but you can use your units to pay college costs practically anywhere in the country and even at schools around the world. Your GET account has the same monetary value whether your child attends a public university, a local community college or technical school, a private university, or a college in another state.
[As with a 529 savings plan], [y]ou can use your GET account not only for tuition, but also for room and board, books, computers, or other qualified expenses. If your child chooses not to go to college or receives a scholarship, you can transfer your account to another family member, hold onto your account for a change of plans, save it for graduate school, or even request a refund. And, unlike some other savings options, you, as the account owner, maintain complete control over the account and how the distributions are used.
Source: https://529.wa.gov/howgetworks
How much to save for college
We didn’t tackle how much to save in this article, so use this college savings calculator to get an idea.
Happy education savings!
Addendum – What if my kid gets a scholarship
1) The typical 10% penalty that applies to withdrawals NOT used for approved educational expenses would be waived for taking out money equal to the amount of the scholarship earned. However, there would be income taxes on the earnings (see next question.)
In short from http://www.savingforcollege.com/articles/20100409-7-myths-and-realities-of-529-plans:
“Myth 2: If my brilliant or athletic kid gets a full ride, I lose the money in my account.
Reality: As with the previous example, you can transfer the money to another beneficiary. But if your kid’s so talented that colleges are willing to pay to get him or her in the door, you won’t be heavily penalized, says Mary McConnell, director of college savings products for Charles Schwab in San Francisco. “If a child gets a scholarship, the penalty for making nonqualified withdrawals is waived, and there will be income tax only on the account’s earnings.” “
In detail from http://www.kiplinger.com/columns/ask/archive/2007/q0423.htm:
We have three daughters, ages 15, 13 and 11, and have accumulated about $35,000 in state-sponsored 529 college-savings plans for each of them. They are all doing very well in school and could be on the road to scholarships. What happens to our college savings if they receive full-tuition scholarships? Can we use the funds to pay for room and board?
If one of your children is fortunate enough to win a scholarship, you’d be eligible to take a penalty-free withdrawal from her 529 account up to the amount of the award. You would, however, have to pay federal and state income tax on the earnings portion of the withdrawal. To avoid those taxes, you could name another family member as beneficiary of the plan.
Not to worry, though. Even if your child gets a full-tuition scholarship, you’ll probably still have plenty of other bills that qualify for tax-free withdrawals from her 529 plan — including required fees, books, supplies and equipment. As long as your daughter attends school at least half-time, room and board count, too. And if she lives off campus, you can take a qualified withdrawal up to the cost of on-campus housing at that institution, says Doug Chittenden, head of education savings for TIAA-CREF, which administers 529 plans for many states.
In the unlikely event that any money remained after all your children were educated, you could let them use it for grad school, use it yourself, transfer it to another family member, or take it back and pay income taxes on the earnings plus a 10% penalty.
For more information about 529 withdrawals, see IRS Publication 970 Tax Benefits for Education. For details about each state’s 529 plan, see our 529 map.
Q: Are the withdrawals post-scholarship taxed at the parent’s income level, or the child’s (beneficiary’s)?
A: Earnings (but not contributions) on the amount you withdraw would be taxed at the scholarship recipient’s tax rate (your child’s, which is good!), but will not be subject to the 10% additional federal tax penalty.
http://www.collegesavings.org/commonQuestions.aspx
Q: Is there are timeline for when the withdrawals can be taken out penalty-free? For example, if the child/beneficiary receives a $10,000 scholarship for calendar year 2012, can the parent take out $10,000 in 2013 (or 2014, etc) penalty-free, or must they, say, take out the $10,000 in the same year as the scholarship (2012) in order to get out of paying any penalties?
A: There is currently no set timeline for when you can withdrawal penalty free. You can withdrawal as early as the same calendar year but unfortunately, the tax law is not clear on whether the penalty exception for scholarships applies only for the calendar year in which the scholarship is provided and each state has developed their own guidelines for withdrawals.
http://www.bankrate.com/brm/news/529/20050306a1.asp
http://www.get.wa.gov/
For federal financial aid planning, both Coverdell ESAs and 529 Savings plans count as parental assets. This is good because parent’s are only expected to contribute ~6% of their non-retirement, non-home assets, while kid’s are expected to contribute 35% of theirs. (Note that this exclusion of retirement assets in financial aid calculations is a good reason to have your kid start a Roth IRA once they have some high school job savings. The IRA will exclude their assets from financial aid calculations, whereas a savings account or taxable stock account wouldn’t.)
[529 Pre-Paid Tuition plans (versus 529 Savings plans, which I discuss below) are counted as the student’s assets, and thus diminish financial aid eligibility. This is one reason I don’t recommend them. Another reason is that the plans guarantee to cover only in-state public school tuition amounts. Also, many plans only cover tuition, which is often just a fraction (albeit a large one) of the total cost of attending college.]
